From a US winter to a hot NSW

A bad winter in the United States is contributing to weaker global growth and inflation, falling bond yields and an unexpected gift for Australia’s biggest state and its newbie premier as they shake off a “lost decade" of sub-trend growth.

The International Monetary Fund’s decision to cut its 2014 global growth forecast from 3.7 to 3.4 per cent was mainly because of the US economy's whopping 0.7 per cent contraction (2.9 per cent in US-style annualised terms) in the March quarter.

This contraction has been attributed mainly to one-off factors including an inventory correction and the severity of the US weather. The IMF says that means the problems should be largely behind us and the US should grow by 3.25 per cent over the rest of this year and 3 per cent in 2015.

New Zealand’s central bank appears to have taken a similar view. It has just raised its official cash rate in the expectation its economy will grow by a strong 3.7 per cent this year.

In Australia, as in New Zealand, the weak global bond yields will spill into the mortgage market via the banks’ fixed-rate lending.

That will add a further touch of stimulus to the already accommodative financial conditions and it will help hasten the recovery in NSW. As Deloitte Access Economics reminds us, for NSW there’s more to low interest rates than just a boom for builders, lawyers and real estate agents.

The premier state is also the country's biggest financial centre. The financial services sector’s wages and profits account for 12 per cent of the NSW economy, compared with 10 per cent in Victoria and around 5 per cent in the rest of the country. According to the Deloitte-Access Business Outlook report, 80 per cent of banks authorised to take deposits in Australia are headquartered in Sydney.

More cheap housing loans will add to bank profits and employment.

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The housing footprint

Housing has a big footprint. Residential building is labour intensive but still consumes more than half a billion dollars in manufactured and service sector inputs for every billion dollars of construction.

Retail sales also pick up as new homes are furnished and second-hand homes are renovated.

Low interest rates mean a lot in NSW. It’s the state with the biggest mortgages and with a history of the housing tail wagging the whole economy dog, not just for the duration of a quick boom or recession but for years at a time. As everyone knows, the state is on a house building catch-up after years of depressed construction activity.

BIS Shrapnel says construction lagged population growth to the extent that there is a shortage of about 40,000 dwellings.

This is the result of a decade in which Sydney’s high housing prices deterred migrants and forced young Sydneysiders to share houses or live with their parents. For the first time in decades, the number of people per house in Australia rose.

The impact was felt more widely than just in the housing industry.

In the 1990s NSW’s growth was almost identical to that of the national economy. But in the next decade its growth rate halved to just over 2 per cent, less than two-thirds the Victorian rate and worse than South Australia and Tasmania.

An important factor behind NSW’s slowdown was the real estate boom at the start of the decade, which produced a big deterioration in the relative affordability of Sydney housing. Prices at one point almost reached 90 per cent above the average of the other state capitals. Interstate migration moved sharply against NSW in 2001 (the average net outflow from NSW doubled between 2000 and 2002) and remained weak right up until the global financial crisis. NSW’s share of the nation’s population growth collapsed.

Sydney prices stayed flat in nominal terms for most of the rest of the decade while the other cities, led by the Perth, narrowed the gap.

NSW’s share of the nation’s population growth started to recover in the second half of the decade.

However, the state’s residential construction industry remained frozen in its long recession.

It wasn’t until interest rates fell to their current low levels and finance started flowing to developers that the state’s housing industry began to revive.

With the strong dollar holding down business investment in manufacturing and the trade-exposed service industries, housing construction is playing a key role in cushioning the economy from the downside of the mining investment boom.

As New Zealanders will tell you, juggling a high exchange rate, low interest rates and a strong property market is a tricky business.

A return to stronger world growth, more reasonable exchange rates and more normal interest rates would be infinitely preferable and hopefully that isn’t too far away. In the meantime, low interest rates are better than nothing.